$$ Expectancy and Trade Comparison

Expectancy is simply R per trade (sum of R for all trades/# of trades).

A few posts back, we talked about how the stop loss placement affects position size, R-Multiples, and trade win percentage. The example was a $30 stock with a $32 target. The 30-cent stop resulted in a 6.67R profit, while the $1 stop resulted in a 2R profit.

I compare these two trades as follows.

First I want to know break even percentage trade win percentage. For the 30 cent stop, break even trade win percentage is 1/7.7 = 13%. For the $1 stop, it is 1/3 = 33%. These trade win percentages result in an expectancy of 0R per trade.

Second, I want to know the trade win percentage for the higher R-Multiple trade that would equal the max expectancy of the lower R-multiple trade. For the 2R trade, max expectancy is 2R (if you were right 100% of the time). To average 2R per trade with the 30 cent stop, you'd need to be right 39% of the time. [(3.9 *6.67) - 6.1 = 20R over 10 trades or 2R per trade].

Clearly, if I get the 30 cent stop trade right more than 39% of the time, it's always better to take that trade. But to fairly compare the trades, find the midpoint. Being right 67% of the time on the $1 stop trade = being right 26% of the time on the 30 cent stop trade. Both would have an expectancy of 1R per trade.

Finally, I decide whether I feel more confident hitting the 6.67R trade 26% of the time, or the 2R trade 67% of the time.

Drawdown is another consideration. But that is for another post.